Oliver Hart, professor of economics at Harvard, and Luigi Zingales, professor of finance at the Chicago Booth School of Business, say that Bush administration economists have abandoned principle in their rush to bail out financial giants AIG, among others.
The government, Hart and Zingales say, should intervene in the fates of companies only when there’s an actual market failure. Such is not the case in the housing market where homes are deflating to their actual value after years of speculative price inflation. The market is working.
It appears that many people thought that house prices would never fall nationally, and made financial decisions based on this premise. The adjustment to the new reality is painful. But past mistakes do not constitute a market failure. Thus it makes no sense for the government to support house prices, as some economists have suggested.
That’s absolutely correct. Any attempt to artificially prop up home sales prices would fail abjectly, even if such a monstrosity could be funded by an government that’s already projected to be nearly a trillion dollars in the red next year. It would be a fool’s errand to try, one that would result in the loss of billions more taxpayer dollars ala the AIG boondoggle.
So what do the professors recommend? Something that makes damn good sense, namely that the government use its authority to broker mortgage renegotiations so that solvent homeowners can keep their homes and lenders can make the profit they deserve:
Many mortgages are securitized, and the lenders are dispersed and cannot easily alter the terms of the mortgage. It is unlikely that the present situation was anticipated when the loan contracts were written. Government initiatives at facilitating renegotiation therefore make a lot of sense.
Government intervention would be helpful in the mortgage negotiation process because of the scrambled egg-like mess that lenders make of our mortgages. Rather than owning a mortgage for the life of the loan and making the return – and taking the risk – that they signed into existence, lenders swap and divvy up loans to the point that it’s difficult to say who owns what anymore. Brilliant. Small wonder they helped bring this calamity on us – they don’t even know what their assets are.
Hart and Zingales again:
Our desire for a principled approach to this crisis does not arise from an academic need for intellectual coherence. Without principles, policy makers inevitably make mistakes and succumb to lobbying pressure.
That’s what we’ve seen with regard to the repeated AIG bailouts – principles and financial sense cast to the wayside like rubbish that’s served its purpose.